Duke Energy Corp (DUK) recently acquired Progress Energy for $26 billion which, the majority of investors, consider to have added a significant amount of credibility to its balance sheet. The company now boasts greater revenue streams and better access to markets. The effect of the acquisition was visible in the results of the first quarter of 2013 when the profits more than doubled, from a year earlier. The only concern for the company currently, is the large amount of debt on the balance sheet and the rapidly increasing cost of borrowings.
The company's profits for Q2-2013 fell to $339 million from $634 million a quarter earlier; however, the revival of the company started last year when revenues jumped from $14.6 billion in 2011 to $19.6 billion in 2012. Unfortunately, the steep rise in revenues did not result in an equal rise in net profits. This year, the company has profits squarely in focus which has begun to have an impact as profits have grown at a better pace than revenues. Much of the growth in 2012 can be attributed to the $26 billion acquisition of Progress Energy; which, many contend, is now supporting the rise in net profits for the company. Previously, the company has been struggling to grow in this competitive market, with stiff competition for investors from the likes of American Electrical Power (AEP) and CenterPoint Energy (CNP). However, the acquisition of Progress Energy has significantly changed the course of the company. This didn't come without a price. The company invested a significant amount of capital, believing that the acquisition of Progress would enable a higher level of growth. The downside is, naturally, the high interest cost.
The interest coverage ratio has been slowly falling over the years and, many investors fear, may decline further. It was '3.5' in 2008 and has increased to '3.9' in 2011 before falling to just '3', last year. But the rise in profits in the first quarter this year might put the company in a comfortable position in order to fulfill its obligations. EPS has remained fairly constant from 2008 and now stands at '3.07'. The company has limited cash, as profits have been distributed as dividends to its shareholders. The company has also realized the unproductivity of sitting on cash and has recently invested a large amount in short-term securities.
Current assets of the company have doubled in the last 5 years from $5.3 billion in 2008 to $10.1 billion in 2012. The current liabilities have grown at a faster pace from $4.4 billion in 2008 to $10 billion in 2012. This shows that the current ratio has declined slightly, but is still manageable. The acquisition of Progress Energy was made at a level well above the actual book value of the company, which has resulted in an increase of more than $12 billion in goodwill. This has increased the size of the balance sheet significantly but its effect will decrease in the coming periods. The acquisition was mainly financed by long-term debt which doubled last year from $18.4 billion in 2011 to $34.5 billion in 2012. While short-term debt also doubled, to $4.2 billion, as it also consisted of part of the financing of the deal.
Cash flows from operations have been increasing slowly and stood at $5.2 billion in 2012 as compared to $3.3 billion in 2008. Investing cash flows have also been increasing and stood at $4.6 billion in 2008 and have increased to $6.2 billion in 2012. The remaining part of the cash outflows has been financed through debt. The company pays out a large part of its profits as dividends and investments are made through new debt.
This acquisition of Progress Energy should be a boon for Duke. The company declared excellent profits in the previous quarter - which is a step in the right direction. As an investor, I naturally like the solid dividend. However, although dividends may be attractive, taking on more debt raises some concerns as the interest coverage ratio has been falling and debt to equity ratio has been rising. The results in 2012 were not a true reflector of the potential of the company after the acquisition; 2013 will likely give a clearer idea regarding the future direction of the company. Despite the high dependence on debt, this company remains an impressive investment opportunity as it looks to rebuild its position in the industry. It's at times like this, where other investors begin to show signs of concern, that tend to present the most opportune times to invest. With a very low beta and the potential for upside as the acquisition is further leveraged, there is huge potential for capital gains if this company can make the most of 'Progress'.